How Flywheels Build Great Businesses

A flywheel is a reinforcing feedback loop, whereby the output in a system contributes to the input in the next rotation.

The concept of flywheels in business was popularized in Jim Collins’s book Good to Great.

Collins describes how great companies build momentum through consistent effort in one direction. Each push builds on the work done before it.

Flywheels are a mechanism behind order-of-magnitude gains over long periods.

Read on to see why entrepreneurs, operators, and investors need to adopt flywheel thinking to produce outsized returns.

What are flywheels?

In the physical world, a flywheel is a heavy wheel that stores the energy you put into it. Each push adds to its momentum, so the faster it spins, the less effort it takes to keep it going.

Nathan Barry, the founder of the software firm Kit, writes about his experience setting up a water pump for an orphanage in South Africa.

Barry goes on to describe the three laws of a flywheel:

1. Activities flow smoothly from one into the next

2. Each rotation is easier than the previous one

3. Each rotation produces more than the last

The selection of tasks needs to be deliberate.

Activities must work together to produce a result.

That result needs to be fed back as an input into the next push, which becomes easier to do and produces more.

For this to happen smoothly, the order of tasks has to make sense, and there should be no more tasks than needed, because every extra task adds friction and slows the wheel.

Business flywheels:

I split business flywheels into two types:

1. Process Flywheels

2. Advantage Flywheels

Process Flywheels

A process flywheel is a loop inside one business function, where each cycle makes the next one easier and more productive.

Nathan Barry gives a good example of a process flywheel within the content marketing function.

He demonstrates how easy it is to create impactful content topics. The steps below are adapted from his flywheel for generating content ideas.

• Write a blog, lead magnet, or content of any kind

• Send an email to subscribers (or a target audience for newbies) asking for their feedback. Ask them what content topics they would like to consume.

• Process responses

• Create content based on the feedback received

This increasingly tailored content will generate a larger audience.

The large audience will provide better (and more) feedback.

Better feedback will result in better content.

Applied feedback is critical in making flywheels work.

Asking for customer feedback after a sale can result in better products. The improved products can bring in more customers.

Asking for testimonials is another process flywheel. Sharing testimonials with prospective customers on a sales page or over sales calls can result in tremendous growth.

These new customers can bring more feedback and testimonials. And the cycle goes on.

Flywheels can and should be built into as many processes within a business as possible. A process flywheel is not a competitive advantage in itself, because a competitor can copy it.

Advantage Flywheels

An advantage flywheel is a feedback loop that makes a company’s competitive advantage grow over time. The idea, and the two sketches below, come from Max Olson’s post on Advantage Flywheels.

These businesses can have one or more feedback loops.

There are a few types of competitive advantages that a company can build.

A company like Walmart is a low-cost retailer. Walmart’s main competitive advantage is economies of scale.

Economies of scale give companies like Walmart the ability to keep pushing prices down. Lower prices deter competition who have a higher cost base.

Walmart also has a strong brand.

Its ultra-low prices have given it a reputation for being ‘the’ lowest price retailer. Shoppers who trust that reputation do not compare prices elsewhere, which lowers searching costs. This brings in more customers (and sales), which ultimately reduces costs and prices.

Amazon has three feedback loops that reinforce each other.

The first is Economies of Scale. From day one, Jeff Bezos set out to build an online retailer that had the widest selection and the lowest prices.

Once this flywheel was set into motion, Amazon developed a brand around selection, pricing and convenience. This fueled its scale (and lower prices) further.

In 2000, Amazon opened its site so other 3rd party merchants could sell their products to Amazon customers.

This is the third loop, a two-sided network effect: more buyers attract more sellers, and the wider selection brings in more buyers.

All three of Amazon’s flywheels reinforce each other. They result in a company that has grown to over $700 billion in annual sales and is nearly impossible to compete with.

Flywheel’s in strategy:

Michael Porter, often called the father of modern strategy, argued that strategy rests on a distinct market position.

He explains that a business needs to determine its strategic positioning. (Is it a low-cost producer or a differentiator?)

Once the strategic positioning is set, a business needs to create alignment across its internal processes (the value chain). Alignment means that each function operates in a way that is consistent with the business’s strategic positioning. Porter calls this fit.

This also means that strategy requires choosing what not to do, because activities that suit one strategic position undermine another.

A business can’t offer luxury products and skimp on marketing. There are trade-offs that have to be made.

For flywheels to work optimally, process flywheels across the value chain need to be aligned. Additionally, all processes need to be consistent with a business’s strategic positioning. Processes and strategy needs to be designed so that each aspect of its value proposition reinforces the others.

This gives investors a test. When analyzing a business, look for the flywheel in its strategy. Then look for evidence that it is working: each turn should cost less effort and produce more than the one before.

The essence of flywheels:

I previously wrote a two-part series on wealth creation. In it I argue that wealth is the result of two factors:

1. Compounding: A return, reinvested so that the subsequent period’s return is larger, and grows with time.

2. Leverage: Tools that amplify effort. This can be labor, capital, media, or code.

Flywheels are characterized by both elements.

Leverage is the mechanism that allows for each rotation in a flywheel to become easier.

Compounding is the movement of the flywheel itself. The output of each turn is reinvested as an input to the next, so each turn produces more.

Flywheels represent compounding leverage, and that’s why they are so powerful.

Entrepreneurs, operators and investors need to incorporate flywheel thinking into their decision making. Only then can they benefit from the asymmetric results flywheels produce with time.

Thanks for reading. I hope you found this post useful.

If you want to discuss flywheels and how to build them into your business or investment framework, feel free to reach out.